CEO Pay & Firm Performance

The design and efficacy of CEO compensation contracts following an earnings restatement doesn't change significantly but there is a sizable shift seen from option-based compensation to salary, a new study finds.

Option-based compensation is pay based on stock options. The general market movements affect the price of those stock options as opposed to employee-specific performance.

Using 289 restatements, or corrections of past financial statements, of the prior year as the benchmark, Professors Qiang Cheng at the University of Wisconsin-Madison and David B. Farber at the Trulaske College of Business at the University of Missouri-Columbia, found that while total CEO compensation does not significantly change by the second year after the restatement announcement, there is a sizable shift from option-based compensation to salary over this period. The paper was posted on The Harvard Law School Corporate Governance Blog.

The analysis also showed that the proportion of value of option grants to total compensation declined by 5.6 percent for the firms who restated earnings, while control firms, those who did not restate, experienced an increase of 2.6 percent over the same period.

CEOs at half of the firms who restated earnings studied left within two to three years.

The overall results suggest there are economic benefits to firms that reduce their CEOs’ option-based compensation. The reduction in option grants allowed managers’ adjust equity incentives to optimal levels.

In some cases, there is a higher likelihood that restatements will reflect income-decreases because as the economy continues to struggle, those stock options' prices will decline. As such, option-based compensation is a concern.